Investing, Asset Allocation, Economics & the Search for the Bottom Line

US Economic Profile | 6.18.14

It seems that macro threats are popping up everywhere these days, but the broad trend for the US economy has yet to show substantial signs of stress overall. The May update of a diversified set of 14 economic and financial data sets continues to track positive with regards to measuring business cycle risk. There are some cracks that deserve monitoring—rising oil prices, weak housing data, and a wobble in consumer sentiment. But the majority of indicators in the aggregate still look encouraging. Near-term projections imply that the upbeat trend will soften a bit in the months to come but otherwise roll on.
Using a methodology outlined in Nowcasting The Business Cycle: A Practical Guide For Spotting Business Cycle Peaks, a broad review of economic and financial trends show that recession risk remains low. The Economic Trend and Momentum indices (ETI and EMI, respectively) remain at levels that equate with expansion.

Let’s dive into the numbers, starting with a summary of ETI and EMI’s individual components:

Reviewing the historical record for ETI and EMI shows that both business cycle benchmarks are well above their respective danger zones: 50% for ETI and 0% for EMI. When the indexes fall below those tipping points, we’ll have clear warning signs that recession risk is elevated. For now, however, there’s still a comfortable margin between current values for May (86.7% for ETI and 8.6% for EMI) and the danger zones.

Translating ETI’s historical values into recession-risk probabilities via a probit model also suggests that business cycle risk is low. To be precise, the data implies that the odds are virtually nil that the National Bureau of Economic Research (NBER)–the official arbiter of business cycle dates—will declare last month as the start of a new recession.

Now let’s consider how ETI’s values may evolve as new data is published in the near future. One way to estimate expected values for this index is with an econometric technique known as an autoregressive integrated moving average (ARIMA) model, based on calculations via the “forecast” package for R, a statistical software environment. The ARIMA model calculates the missing data points for each indicator, for each month through July 2014. (March 2014 is currently the latest month with a complete set of published data). Based on today’s projections, ETI is expected to remain well above its danger zone in the near term.

Forecasts are always suspect, of course, but recent projections of ETI for the near-term future term have proven to be relatively reliable guesstimates vs. the full set of monthly reported numbers that followed. (That’s not surprising, given the broadly diversified nature of ETI. Predicting individual components, by contrast, is prone to far more uncertainty in the short run.) As such, the latest projections (the four tan bars on the right in the chart above) offer support for cautious optimism. The chart above also includes the vintage ARIMA projections published on these pages in previous months, which you can compare with the complete monthly sets of actual data that followed, based on current numbers (red circles). The assumption here is that while any one forecast for a given indicator is likely to be wrong, the errors may cancel one another out to some degree by aggregating a broad set of predictions into ETI.

For additional perspective on judging the value of the forecasts based on the historical record, here are the previous updates for the last three months: